Treasury Department to Issue Tax Guidance on NFTs

Last week, the Treasury Department issued a notice that it intends to issue guidance clarifying the tax treatment for Non-Fungible Tokens (NFTs), which are typically used to convey ownership of digital or real-world items using blockchain technology. The notice signals that many NFTs will likely be treated as “collectibles” for tax purposes, subjecting gains from NFT sales to a 28 percent tax. The IRS is accepting public comments on the notice until June 19, 2023.

Previous draft guidance from the IRS lumped NFTs in with other digital assets without clarifying whether they ought to be taxed as collectibles. Since most digital assets are taxed at the lower long-term capital gains rate of 20 percent, this left some uncertainty around how the IRS viewed NFTs for tax purposes. 

The clarification brings many NFTs in line with other collectibles like works of art, assets over which NFTs often confer ownership. Organizations like Fidelity Charitable have explored using NFTs to fundraise, and raising taxes on NFTs would further incentivize owners to gift them to charities by effectively increasing the size of the charitable deduction taxpayers can claim. Intermediaries that can help facilitate NFT donations exist, but the process appears less straightforward, likely because liquidating an NFT that represents ownership over a piece of art is more challenging than converting assets that are more heavily traded, like Bitcoin, into cash.

The NFT market has dipped since its boom in early 2021, but nearly $500 million worth of NFTs trades were made over a 30-day period earlier this year, suggesting that collectors remain engaged with the NFT marketplace. A larger share of the NFT marketplace may be primed to flow to charities now that the IRS seems poised to raise tax rates on this bucket of crypto assets, but the charitable sector may have to build out its infrastructure to make it easier to donate NFTs and allow nonprofits to engage with NFT owners more directly.

The Treasury notice follows a string of Biden Administration actions that suggest the White House is growing more inclined to assert itself over digital asset policy. The President’s FY2024 budget request included more proposals to modernize tax rules for digital assets than in previous years, and the White House Council of Economic Advisors’ (CEA) 2023 annual report was heavily skeptical that crypto businesses can offer tangible benefits to consumers. The CEA’s report in particular marks a sharp departure from the Administration’s 2022 framework for digital asset regulations, which took a more balanced approach by calling for policies that not only mitigate risks but also promote innovation in the crypto sector.

We’ve covered how a divided Congress may struggle to build the bipartisan consensus necessary to advance meaningful digital asset legislation, which makes the Administration’s apparent shift all the more important. Democrats may take some cues from a White House that seems to be growing more suspicious of the crypto sector, potentially reducing their willingness to work with Republicans who look more favorably on the industry. Additionally, regulators may feel the Administration’s change in tone empowers them to turn a harsher spotlight on the crypto sector. In short, it appears as though the crypto sector will continue to face detractors in Washington who could make it more challenging for the industry to advance its priorities in the years to come.

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